Author: johnredwood

The Chancellor has promised a statement next week to try to sort out the regulatory mess that characterised the Northern Rock debacle.

What he needs to do is the following:

1. Ensure the Bank of England is more than just a monthly tea party for a group of academic economists sitting round talking about interest rates. The Bank needs to be given the power to direct and deal in government debt (currently with the Treasury).

2.The Bank needs to be a hands on operator in the money markets, so it does not allow in future the markets to become as illiquid as they were in August and September 2007, nor as loose as they were a year or more earlier. The Monetary Policy Committee became entirely academic last year when market rates diverged from MPS rates by up to 100 basis points. If the Bank is to set interest rates, it has to have all the powers and knowledge to operate successfully in money markets, to enforce the rates the MPC recommends.

2. Transfer banking supervision from the FSA to the Bank to allow the bank to operate properly in markets.This would ensure the Bank saw the main positions of the big banks daily, and understood the minute by minute pressures in money markets better.

3. Press for amendment of the EU MAD Directive to allow the Bank to organise rescues for ailing financial institutions in private and rapidly if needed.

4. Renegotiate Basel II to strike a better balance between off balance sheet and on balance sheet items, and to avoid Basel II becoming a further tightening of the capital rules at a time when banks are already finding it difficult to lend through balance sheet pressures.

5. Announce that the UK will not support any more EU regulations of financial services – there are too many new ones that have not yet bedded down, and we need a period of reflection and implementation to see how they will work.Some will need amendment or repeal, as they are too proscriptive and will drive busienss offshore from the EU.

6. Review the operation of the Rating agencies with other overseas jurisdictions, to see if they can operate more cautiously in future.

The sub prime crisis, a run on a UK mortgage bank, and now the loss of $7 billion dollars through rogue trades at Soc Gen: and still they say regulation works!

I accept that financial services businesses can be different. Where they take money from people, on the promise they will repay it at some date in the future, people need reassurance that the promise will be kept. In most other businesses the business takes the risk and supplies the good and service before the customer pays.

It makes sense to have deposit protection, and it should make sense to have some additional checks and requirements to reduce the risk that a business will steal people’s money, or will fail to keep enough capital to pay for losses and mistakes and still be able to give people their money back when they want it or are entitled to it.

This proposition has led to a vast regulatory industry, where clever regulators try to interfere in ever more details of the banks’ lives in the belief that this will prevent mistakes being made. As the last few months have shown, it does not work.

We need to ask how did the world regulators get it all so wrong, and what changes do we need to reduce risks in the future?

The biggest problem is the so-called sub prime crisis, which is in practise a world crisis, not just a US one, and is not confined to mortgages alone. It is a securitisation and off balance sheet crisis – too many banks packaged up too many loans born of the easy money conditions the authorities encouraged, and spread them around the system. The Regulators through their Basel I requirements positively encouraged this, asking for less capital if you securitised your lending and pushed it off your own balance sheet. This crisis should be called the Basel regulatory crisis, rather than the sub prime crisis.

The solution is for monetary authorities to be more careful about making money too easy – not that this is an immediate problem in the middle of the Credit crunch! They also need to revise rules over capital requirements, without lurching to a position where too much banking capital is required, intensifying the Credit Crunch. The whole thing is complicated by the move to Basel II, which needs urgent review in the light of current circumstances.

The run on Northern Rock was an unfortunate event for London. I do not agree with the MPs who say the FSA got it all wrong. As I understand it, the FSA was warning about the problems of Northern Rock well before the run on the bank began. The failure was a system failure, which owed a lot to the failure of the monetary authorities to keep money markets liquid, and to the dithering of the Chancellor who was meant to hold the ring and make the decisions in areas of overlap between the Bank and the FSA.

The UK government should decide that in future the Bank of England will get back its old powers to regulate banks and to run the government’s debt financing programme, so it once again sees the whole range of business going through the money markets. The Bank should have prime responsibility for banking the commercial banks, ensuring adequate liquidity in markets and avoiding any future run on a bank. They always used to be able to do this before Brown’s botched reforms.

The Soc Gen debacle is difficult to believe. Most banks make dealers deal in open dealing rooms where colleagues can hear what they are up to. I thought most require two signatures on larger deals, most have real time reporting through a common system, and anyone needing cash to pay margin or settle transactions would need someone else to certify or check the requirement. As the trader apparently acted without other authority he must have found ways to circumvent the checks in the system. The regulator presumably was completely unaware that such a thing was happening.

I do not think Regulators can stop a Soc Gen event. Only better internal controls and procedures in a bank can do that. The fact that Regulators cannot should make more people suspicious of the cry that what we need is more regulation. In this case what we needed was better bank management.

Three cheers for the Fed. One cheer for each 25 basis point cuts in interest rates announced as an emergency measure yesterday. It did the trick, limiting the savage market decline, and turning round the Asian markets which had been in freefall the previous day.

The US authorities have made it clear to the markets that they are going to stop a recession if it is in their power to do so. They have made aggressive moves in reducing interest rates. This will help a great deal. It means that many mortgage holders and companies in debt will now be able to afford their interest payments and repayments, improving the quality of the loan assets on the balance sheets of the banks and those held in securitised form. It means that all those financial companies that have borrowed so much to sustain the easy credit of earlier years will also have some relief on the amounts they have to pay in interest. The whole financial structure in the US is a little less unstable as a result of this development.

As I argued yesterday, two conditions need to be fulfilled for recovery to get underway. The first is lower interest rates. The second is the recapitalisation of the banks, so they have the stronger balance sheets they are going to need to lend people and companies more money again. This process can happen by the passage of time, as they trade profitably. It can be speeded up by cutting or cancelling dividend payments, or by raising new money from shareholders.

The gyrations of world markets in the last few days shows that the Indian, Chinese and Japanese markets are still very influenced by perceptions of the state of the US economy. All three are important exporters to the USA and are influenced to some extent by US conditions. The internal strength of the Indian and Chinese economies is becoming more obvious, but it is not thought sufficient to offset the full blown US recession which some market participants feared.

The Governor of the Bank of Englands remarks showed how far behind the plot the UK now is. The worse circumstances of the UK economy as a result of recent policy are now dragging it down relative to the US and the Asian giants. As the Governor pointed out, we have a bad inflation problem this winter. The governments own borrowing requirement was far too large before Northern Rock hit, only to be made far worse by the Northern Rock debacle. The big build up in UK public spending and borrowing, and the poor productivity of the enlarged public sector, all limit the UKs room for manoeuvre, at a time when the UK too needs lower interest rates to relive pressure on its financial system. The government is trying to control public spending at last by clumsy interventions on public sector pay, but still lacks a grip on large projects and staff numbers.

A recession can be averted in the US. The UK will experience a sharp slowdown, which will be made worse if the Chancellor presses on with plans to increase capital gains tax on entrepreneurs and with damaging plans to tax non doms too much.

Traffic Blackbook Review

The collapse of Stock markets around the world should come as no surprise. As readers of this blog will know, the years of easy credit were decisively ended last August when the financial community woke up to the reality of the securitised loans crisis, aided by the Central Banks at last in tighten mode after years of sloppy credit.

A credit crunch means there is little new credit available at a time when too many people and companies are desperate to sell assets to raise the cash they need. Investors with cash suddenly decide they want to hold more cash. Investors who have been investing on borrowed money have to rein back their activities and pay down debt. Banks that were able to lend people money and then package the loan up as security to sell to someone else suddenly find there are no buyers for these packages. As a result asset prices crash.

A credit crunch ends when two conditions are met. The Authorities have to signal they want easier credit by lowering interest rates, so high borrowings become affordable again. Banks have to sort their balance sheets out so they have the capacity to lend more. It is this latter condition which may take some time to get right this time round, because so many banks have been involved in syndicated credits and in trying to put their loans off balance sheet in structured vehicles. The sooner the banks sort out what all these investments are worth, write them down, and raise the new capital they are going to need to be able to carry on their business, the better.

The weakness of banks is not solely a US phenomenon, and the so called sub prime crisis is not just a US or a property related difficulty. This is a crisis in the global banking system, where there are worries about the Bank of China as well as about the European and US commercial banks. They have to contract their balance sheets as they value their loans more realistically, and then many of them will need new capital ??whether by cutting dividend payments and keeping more of their profits, or raising new money directly by selling new shares to shareholders. Doubtless the worlds regulators, led no doubt by the UK authorities, will make it even more difficult to by tightening the rules on capital adequacy at exactly the wrong point of the cycle.

The worlds economies are in different conditions to meet this sudden lurch from easy money to tight money. The Italian and Spanish economies are going to be made to suffer for their membership of the Euro, with interest rates and money growth dictated from Frankfort leading to painful adjustments in their domestic economies. The US economy is so far mainly suffering in the real estate and banking sectors, with some signs of a good export led recovery emerging in other sectors from the lower dollar. The UK economy is badly placed, thanks to the very high public deficit and poor productivity performance of the much bloated public sector. The bungled approach to money markets and banking which uniquely gave London the only run on a bank does not help either. If the Chancellor follows this up by taxing the rich out of London then we will have a major residential property price collapse to add to the current woes. The Indian and Chinese economies may find exporting to the US and the West more difficult, but they have the cushion of rapidly growing domestic demand and China has the huge foreign exchange reserves its successful exporting has built up in recent years.

We have seen a sharp contraction in real estate in the US, in Spain, and in commercial property in the UK. We are now seeing a sharp fall in share prices, as investors adjust to the new reality that banks and property companies will find it difficult to maintain earnings, and as the growth rate of the worlds main economies slows.

There remains plenty to worry about. Some are still worrying about the price rises that are coming through this winter as a result of the years of easy money. Others are worried looking forward, fearing a recession in the US and elsewhere. I still think a full blown US recession unlikely, and do not see an inflation problem looking out a year, but recognise that these fears will remain real to many unless and until my two conditions are met for a recovery.

There will be growing pressure on the US, UK and European authorities to lower interest rates, and lower rates will help. There also needs to be a concerted drive to clean up banksbalance sheets and establish some kind of a market in all of these securitised loans that characterised the years of easy money. Once we can know what is left on banks balance sheets, markets can get on with the necessary task of recapitalising the banks so more normal credit conditions can be recreated.

PS: The Fed’s move today to cut interest rates by 75 basis points, taking them down in one go from 4.25% to 3.5% is a good start.

I am glad to have won the battle against Vince Cable to avoid nationalisation of Northern Rock. I am grateful to the Jeremy Vine programme and the Week In Westminster for giving airtime to the case against nationalisation. Their commonsense and fairness shows up the lamentable performance of the Today programme, the World at One and Pm who gave ample platforms to the pro nationalisation case but refused me the opportunity to explain why it was a bad idea, and to offer a more positive alternative.

In the arguments with editors I was told that my proposals were unlikely to be taken up, whereas nationalisation was the likely outcome. I explained that the government had to come up with something better than nationalisation because nationalisation would have wrecked the borrowing and spending figures. The BBCs flagship programmes as always remained wedded to an old fashioned state solution and to the Lib Dems, so their listeners were not made aware that there was a better way, and were in ignorance that the governments advisers were working on it.

I am pleased this morning that the government has decided to

1. Avoid nationalisation
2. Get some cash back more quickly by selling bonds to replace the loans
3. Seek a new private sector owner
4. Take an equity stake via warrants to give the taxpayer some profit if it recovers well.

What I want to see in addition is

1. Proper banking disciplines enforced to repay the borrowings. Northern Rock still needs an injection of tough banking controls to make it work.
2. A phased withdrawal of the guarantees ?? we dont just want the cash back, we also want to get the taxpayer off risk
3. A fair competition allowing in new bidders ?? as the basis for bidding is now very different from before Christmas. Otherwise there could be legal challenges.

The government needs to:

1. Get a grip on its lending to Northern Rock and set out how and when it will be getting money back from this bank.
2. Remove wasteful and unpopular public spending, like ID cards, regional government, extra contributions to the EU, too many spin doctors and consultancy contracts.
3. Start applying pressure to raise public sector productivity in those areas where we do need spending. Impose a staff freeze on the civil service.
4. Cancel the increase in CGT from 10% to 18%, and leave the new 18% rate in place of 40%.
5. Issue more index linked bonds to finance the remaining deficit, as inflation will come down after this winter’s fuel and food rises.
6.Create an employee ownership scheme for the Post Office and press ahead with its privatisation involving employees.
7. Open the water industry up to competition, to bring prices down and open up new supplies and new investment.
8. Get on with commissioning private sector investment in energy capacity by granting the necessary licenses and planning permission.
9. Introduce more private capital into railways, reuniting track and train in regional private companies.
10. Call a halt to the overregulation of financial services from Brussels, and put through deregulatory legislation which starts to lift the burdens on business.

This programme would at one and the same time

1.Lower prices by using competition to cut monopoly prices
2.Increase investment in infrastructure where we are short of capacity by harnessing private capital
3.Reduce public sepnding
4.Allow lower interest rates as a result of 1 and 3 above.

<p> The idea that Northern Rock loans will be packaged and sold to the private sector is not a solution to the crisis, especially as there will be a government guarantee on them. Instead, this represents a decision by the government to lengthen the period over which it is prepared to lend to Northern Rock.</p>
<p> It means that all interested bidders wanting to buy a share of the action in Northern should; be invited to rebid, as the terms on which they are bidding are now so much better than they were. It appears that a bidder now has the government as its bank manager, guaranteeing substantial lending, for a long time period. This is a much better proposition than the one they sought bids for before Christmas.</p>
<p> No-one writing up the story seems to grasp the importance of adopting the recommendations that readers of this blog know well, recommendations to the government and Bank of England to get a grip as Northerns most important bank managers.</p>
<p> Whether Northern is to be nationalised, sold to a private bidder or remain independent, the need is the same. It is high time the authorities toughened up the terms of their lending to Northern Rock, and set out a timetable for repayment that is demanding but realistic. It should be up to the management to decide if they can repay from trading profits and cash, or if they need to sell assets to meet the demands for money back by the taxpayers.</p>
<p> I find it almost unbelievable that Mr Darling and the Bank should make maybe £55 billion of loans and guarantees available to Northern Rock with no public statement of how long they can have the money for, how the asset cover has been secured, and when the money has to be repaid. All these things should be public because they have such a big impact on public spending, and so bidders can form a proper view of the value and the liquidity of the business. More worrying is the likelihood that there is no private agreement about how and when the loans will be repaid. What private sector banker would ever lend large sums to a distressed company without first asking and answering the questions How and When do I get my money back?</p>
<p> The governments decision to back the “solution” of selling bonds to the private sector to release cash to the government that it has lent to Northern would work well if there were no government guarantee, but the existence of the guarantee keeps the taxpayer on risk. At the very least if they wish to go this route they should look at time limiting the guarantee, or phasing it out.</p>
<p> This could prove to a dear way of avoiding the ruin of nationalisation. Maybe one day the Treasury will wake up and understand that they have a banking problem. The way out is by applying proper banking disciplines to this business, and making the shareholders and directors of Northern Rock confront the simple truth either they trade their way out of the borrowings, or they sell assets to repay the borrowings. Nationalisation, or lengthening the terms of the loans and guaranteeing them take the pressure off the management. A sensible bank manager with that much money at risk with a single client would want to hold their feet to the fire, not let them off in the way the latest proposal does.</p>

Things are bad enough without talking ourselves into recession.
Some banks and commentators have already called a recession in the USA, when the figures for the last quarter of 2007 show the US economy was still growing well. Here in the UK the retailers have added to the sense of gloom by concentrating on their sales figures on a ??like for like?? basis, leaving out all the sales in new shops.

The current position is both better than the pundits admit, and worse than the government will let on. The bad news is that the banking systems in both the USA and the UK are damaged by discovering that some of the lending they carried out in the heady days of low interest rates and easy money has been in their balance sheets at values that can no longer be sustained. We are living through a difficult time as banks adjust for the losses they have made, and rein in their lending as they are short of cash. In the UK commercial property values are falling fast, undermining the security for some of the loans. Residential property values are under attack from the UK government, who want housing to be more ??affordable??, but are being held up in part by the high Stamp duties and the imposition of Home Information Packs which is deterring people from selling their homes and buying a different one. There are too few homes coming onto the market at the moment to cause a crash in prices. The UK authorities have made the problem worse by their ham fisted approach to Northern Rock and by their failure to keep markets liquid enough during the last four months of 2007.

The good news is that many companies are still trading well. Profit margins are good in many cases, and on both sides of the Atlantic activity is higher overall today than it was when the Credit crunch first hit. Both the US and the UK have experienced a falling currency. As both economies need to divert much more activity into exports, or into import substitution, that will help. Both economies can export so much more to the rich parts of the world ?? China, India, Russia and the Middle East. Both economies now have to seek inward investment from these new giants that have built up huge cash surpluses at the same time as we have built up huge deficits by buying their oil and their manufactures. It is repayment time.

Few forecasters expect a downturn in the UK this year ?? just a sharp slowdown. Some commentators expect the US to get away with a slowdown rather than a recession. The US Fed is very keen to stop a slump, and is taking the right action by making cash available to banks and by cutting interest rates. Now the US President is also promising tax cuts, would boost activity as well. The US authorities recognised earlier than the UK that they had to shift from inflation fighting to recession fighting, and they have been bolder in their actions. They will probably succeed in avoiding recession.

The UKs position is weaker because the UK has increased public spending by too much, wasting too much of the money. At a time when other countries were reining in their public deficits and controlling their spending, the UK government went on a spending binge. This limits the UK governments scope to cut taxes and relieve the pressure on consumers. As consumption is the largest part of activity, this means we are going to experience a slowdown which consumers will feel badly. If the government really wanted to help us out of this change of fortune, it would get a better grip on its spending immediately, cancelling the needless parts like ID cards, computerisation schemes, regional government, and larger EU contributions as well as keeping wages down. Then it could follow the US example and cut taxes to help the hard pressed private sector.

Instead the UK is only going to tackle one of the twin deficits, the balance of payments one, through the mechanism of a cheap pound. Our best hope this year is that the strategy works and the private sector does shift a lot of activity into exports. That could be helped if the government would relent on its planned increases in small business tax and CGT. They need the goodwill of entrepreneurs to right the imbalances in this economy. Its a dangerous time for the government to be sandbagging the very people on whom they rely to recreate their much quoted ??economic stability??. Our economy at the moment is as stable as a row boat in a storm.

There is no need to talk ourselves into recession ?? we can get through with a period of slow growth. To do so, the government needs to curb its own appetite for waste and be realistic about how much it can squeeze out of us in tax.

What price an ethical foreign policy?

Today sees Mr Brown in China trying to act as a super salesman for British business. It is a relatively harmless use of his time, forced upon him by the dire straits of the UK economy under his policies.

Mr Brown has debauched the strong economy he inherited. His first couple of years wisely continued Conservative spending plans and repaid public debt, but elsewhere the long march of this government to a malfunctioning socialist economy had begun. The undermining of the Bank of England proved to be a long fuse to the explosive Northern Rock crisis. The taxation of pension funds began the route march to most people no longer having the benefit of a final salary scheme, whilst burdening too many companies with large deficits to repay.

Worse followed after 2001 when Mr Brown embarked on an irresponsible twin track ?? easy money, and massive spending increases on public services. Because he wrongly saw all public spending as ??investment?? and felt large sums were proof of better service, he failed to ask the obvious question ??What am I buying for all this cash??? The answer turns out to be a whole load of extra civil servants, spin doctors, consultancy contracts, pay awards, quangos and regulators.

Ten years on the UK is one of the world leaders for twin deficits ?? a record balance of payments deficit, and a large government borrowing requirement. Alarmed by the record deficits on the balance of trade figures which he used to pour over to harry the Conservatives when in government, he decided on a trip to China. It is a sign of his desperation that he feels the need to act as pied piper to the British business community to sell more there, and to see the need to ask the Chinese government for more Chinese funds to be invested in the UK. He is right we require the money, to pay for our double deficits.

When the Labour government first came into office its then Foreign Secretary Robin Cook claimed they would run an ethical foreign policy. The phrase was chosen to imply that all previous UK foreign policies had been other than ethical. The Labour knight was to wear the purest white, and would charge into world Councils with morality as the billowing pennant on the lance.

Today that seems a very long time ago. We look back on the invasion of Iraq, the continuing fighting in Afghanistan, the lack of any action over Zimbabwe, the skirting round North Korea, the inconsistent approach to other countries gaining nuclear weapons and the erratic response to human rights abuses and have to ask what ethical or moral stance now lies behind these actions? Arent they all driven by media, by events, by US pressure, by EU argument, by a growing sense in the present Foreign Office that there are many obvious limits to British power?

Worse still, when many want Mr Brown to raise Chinas human rights record as the central issue whilst there is still a window of opportunity before the Olympics, many of us are embarrassed to say this when we look at the deteriorating record of human rights in our own country. Now the UK wants to have the western record for detention without trial or charge, seeks to stifle public opinion by ratting on the promise of a referendum, spends a fortune on clumsy physical ??security?? at so many places and events, treats travellers like suspects or criminals and intensifies the range of thought crimes that preoccupy the elite, we are no longer in a good position to lecture China even if we wanted to.

Mr Browns visit recognises the reality of the new world order. China is emerging as a superpower, with a fast growing economy, a large population, and a wish to project its power. When a country has more than $1 trillion in the bank it is difficult to argue with it, especially when our country has been newly impoverished by Mr Browns policies. He sold our gold holdings for a fraction of its current market value, ransacked our long term savings, failed to stop a run on a British bank and now needs to go cap in hand to China to seek inward investment to the UK. These are sorry times for our country. They have been brought on by incompetent stewardship of our money. It is humiliating to see our Prime Minister ask for sovereign wealth fund money from China to keep us afloat. If he really wanted to improve the UK economy he should have stayed at home, working on how to get more value from his public spending, and how he could curb spending so we do not need to borrow so much.

The debate about Northern Rock on Newsnight yesterday failed to produce a thought through alternative to nationalisation, to protect the taxpayers interest and avoid more damage to markets.

As readers of this blog will know, there is such an alternative. Maybe I have to spell it out again.

The government and the Bank should set Northern Rock targets to

1. repay debt
2. generate cash and profit
3. sell assets

These targets should be tough but achievable. The rate of asset sales should be geared to what the mortgage market can absorb, so the assets can be sold for a reasonable price, leaving the taxpayer with sufficient cover to get our money back.

Putting Northern Rock into administration could lead to a fire sale of assets, and might result in taxpayers not getting all our money back.

Nationalising Northern Rock could lead to huge losses for taxpayers, as taxpayers became responsible for all the rest of Northern Rocks assets and liabilities, including paying the staff, any redundancies, and the pensions shortfall.

Northern Rock has started to follow this managed run off strategy, selling ?2 billion of mortgages recently and using this to repay some of the taxpayer debt.

The meeting today at Northern Rock has been called to try to limit the managements scope to make decisions. This could be used to limit the Companys ability to reduce its debt to taxpayers, so it is not a helpful development from the governments or managements point of view.

The meeting is also a reminder to those who think nationalisation is an easy option, that it could be bitterly fought by existing shareholders. Taxpayers would not take kindly to existing shareholders being offered a good price for their shares, whilst existing shareholders are likely to contest nationalisation for a nominal or low price. I cant understand how anyone sensible can think this would be a good route to follow.